Rallying Anew: Avg. Junk-Bond Yield Falls Below 6% Again

By Michael Aneiro

Junk bonds are back on the mend following their recent brush with de-leveraging and interest-rate risk, with the average yield across the high-yield market dipping below 6% again, per the latest 5.994% reading on the Bank of America Merrill Lynch High Yield Master II index. That yield dropped under 6% for the first time in market history back in January and had fallen below 5% in early May, when the average junk-bond price surged to a record 107.2 cents on the dollar. The subsequent bond-market sell-off lifted that yield as high as 6.82% last month and cut that price to 100.7 cents (it’s now at 103.2).

None of this, of course, had anything to do with any surge in corporate defaults – it was mostly a reaction to the spike in interest rates and a concurrent pullback in risky, overbought investments, after the Fed in May started (in)articulating its plans to wean markets off its $85 billion in monthly bond purchases. Fed Chairman Bernanke’s more recent dove-like noises have soothed market nerves and helped both rates and risky assets rally again.

Now, “compensation for credit risk appears attractive,” according to Goldman Sachs Asset Management. GSAM points out today out that over the past two decades, risk premium (difference between corporate bond yields and yields on comparable Treasuries, currently 4.68 percentage points for junk bonds) has accounted for 54% of all-in junk-bond yields; today it stands at 78%.

Longtime junk-bond guru Marty Fridson, currently CEO of financial research firm FridsonVision LLC, says the average yield is still half a percentage point below what he calculates as fair value, and if the market reverted to that fair value with no change in the underlying Treasury yield, investors would incur a loss of about 2.25% of their market value, putting a sizable dent in the sub-6% yield they expect to earn over the next 12 months. More from Fridson:

Income-hungry investors are once again willing to camp out in Tornado Alley to collect a little extra yield. They are not settling in, but rather are prepared to vacate the instant the rising-interest-rate alarm sounds again. With memories of the last flight from high yield bonds still fresh, the next one is likely to represent an even uglier scene of panic. Liquidations by high yield ETFs will almost certainly accentuate the price declines.

Fridson points out that the average junk-bond yield has been above 6% on 97.5% of the trading days over the past 16 years, and now that it’s back below 6% “investors will have to decide how well they like the odds that it will remain there for very long.”

Looking at the two big junk-bond exchange-traded funds Thursday afternoon, the iSharesiBoxx $ High Yield Corporate Bond Fund (HYG) is up 36 cents to $93.76, and the SPDR Barclays Capital High Yield Bond ETF (JNK) is up 16 cents to $40.62.